China has been promoting inclusive finance in recent years, striving to reach less affluent individuals and small companies.
This is because people in rural areas, smaller and medium sized companies, entrepreneurs, and individuals without a credit history are often unable to obtain financing and are forced to turn to the curb market for often very high interest loans. Last week, the China Banking Regulatory Commission posted guidelines that require medium and large size banks to set up departments for inclusive finance. This is another step in the right direction and promises to promote growth — although risks must be maintained.
Drive for inclusive finance
China recently published guidelines for larger banks on organizing inclusive finance divisions, a move that echoed the State Council’s order at the beginning of May for large banks to create these departments. Banks are to allow for a somewhat higher level of non-performing loans for small borrowers.
This is part of a greater effort to expand the financial system to firms and individuals that may be considered riskier borrowers due mainly to a lack of credit history or collateral. The State Council even laid out a five-year plan for inclusive finance from 2016-2020, which calls for “satisfy[ing] increasing demands of the public for financial services, especially enable[ing] small and micro businesses, peasants, urban low income groups, impoverished groups, the disabled, the aged and other special groups to obtain financial services at reasonable price in a convenient and safe way, without delay.”
Boost to growth
Making finance more available to smaller borrowers has the potential to boost growth. This is because small and medium sized enterprises (SMEs) contribute about 60% of China’s GDP. Most of them are forced to borrow from a variety of sources, including from family and friends, money lenders, and to a lesser extent from banks. The reason for this is that banks have not lent to SMEs in the past, most often due to SMEs’ lack of credit history. The growing social credit system, which seeks to provide a credit history to financial institutions, coupled with the new requirement for larger banks to expand lending capacity to these smaller borrowers, will allow SMEs to spend less time and money obtaining finance.
Lending to the poor, especially those in rural areas, can help to reduce poverty as people are able to pull themselves out of poverty traps. For the poor, financial shocks like sudden medical expenses, loss of employment, or poor agricultural harvests can drive families at the borderline between poverty and viability into desolation. When poor have access to finance, they are able to avoid extreme poverty and tend to spend a larger percentage of their incomes on consumption, generating growth by boosting local purchases of goods and services.
Risks should be controlled
This doesn’t mean that everyone should be able to obtain a loan.
It is as important to control for risks in the area of inclusive finance as in the realm of normal operations. China’s larger banks will have to adopt new risk-control methods, which is something that smaller rural banks have already had to implement. Rural banks, for example, have reduced risk by extending credit lines to villages as a whole or providing loans with joint guarantees. In the case of lending to those with no collateral or credit history, it is also essential to carry out due diligence face to face. The better than lenders can know their borrowers, the more they reduce risks associated with the loans. This increases the costs of the loan but in the long run will help to ensure that the loan is repaid.
In some cases, such as lending in less developed regions, it is possible that lending to small borrowers will be unprofitable. As the State Council has noted, larger banks will have to raise their non-performing loan thresholds for smaller borrowers. However, it is important for large banks to make adjustments to improve the profit outlook for small borrowers, since subsidizing loans to these firms and individuals may not be sustainable, especially under tight credit conditions.
The pro-poor policy of inclusive finance is being implemented in China, promising to further reduce poverty and increase economic efficiency and growth. The extent to which this policy is being carried out in China is exemplary to other developing nations, although risks must be controlled for to ensure that financial inclusion remains sustainable.
Source”timesofindia”]
